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Market Stress Could Lead to Opportunity

As this week slid closer to the hypothetical default deadline of August 2nd, an interesting dynamic took place. First the markets were skittish on Monday. But on Tuesday, the major market indexes sweat off nearly 2% of their value worrying about the outcome of the Congressional debt ceiling debate. Was that an indication of more bearish moves to come or is it merely the fabled wall of worry that bull markets historically climb? The remaining days of the week will give us a clue about whether we are seeing a market in the process of merely stressing out or truly being under serious stress.

My opinions is that all the worry in the markets is simply setting up an excellent buying opportunity. Political activity has rarely done much more than mildly accentuate a move within the market’s larger trend. I heard people, for years afterward, blame the 9-11 attacks for the market’s woes. But as a chart reader, it was pretty clear that the downward trend was well underway long before and continued long after. The highly unusual event and the U.S. Government’s military response in its wake accounted for little more than a two-month blip in what the market was planning to do already.

Similarly today we may well be in a situation where forces external to the market will cause a slight aberration in the prevailing trend of the market. Now you might think that a deliberation on whether a sovereign government should consciously default on its obligations is not external to the market. And you would be right. But you shouldn’t confuse what is going on in Washington with an imminent default on treasury debt. Many have already pointed out that the government brings in 10 times as much each month as it needs to cover the minimum monthly payment on its treasury debt. Everything else is merely a matter of program funding. It’s just politics folks. And politics don’t move the market for long.

It’s true that the technical read of the market looks daunting right now. The ATR is rising, the market has slid five consecutive sessions, and Wednesday’s optimism over labor data was dashed by delayed and cancelled House votes, leaving the indexes below key support lines. Where is the evidence for believing that the market may be over-worried?

Check out this chart and look closely. It could pay off.

Notice that the VIX (black line, is making a higher high, even while the SPY (green line) is not making a lower low. The VIX is pricing in more worry than the markets right now. The VIX typically peaks as the market bottoms. So far we haven’t seen either, but we soon could. And when we do, if the market’s low has not exceeded a previous low level, there is a good chance that the follow-up return of optimism will lead to the market to new highs. As they say, “when the VIX is high, it’s time to buy.” Perhaps that time is at hand.

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